Some of the new-age tech companies had fallen badly after getting listed. Have they now come to a price where you will be willing to buy them now?
Yesterday evening, the closing price of Fresh in the US was $13 86 cents. I always track my Chennai companies first and the closing price puts them with a valuation of less than $4 billion. So roughly, we are looking at about 8 times price to sales on a forward basis. Eight times price to sales is where tech companies have been for the last 20 years for a large part of the time when there was no froth.
So I would say yes, this is probably a good time to consider buying great companies. Maybe I am wrong but I would like to suggest a small framework to look at this entire set of issues rather than look at issues themselves. First is what is the time period with which we are reviewing this? Are we looking at a three-month post Ukraine lens? Are we looking at it as a three-year post Covid lens or are we looking at it as a twenty-year lens?
Question number two is if we are looking at it from a three-year lens, we have a perfect trifecta. There is the economic damage of Covid, then came the sloshing liquidity that was created to manage Covid and which is now being tightened and almost everybody is raising rates and then of course the repetitive risk of Ukraine war, leading to tremendous amounts of fear.
So Covid unleashed some kind of animal spirit to respond and for humanity to survive as much as it created a recession. Now liquidity is being withdrawn and risk appetite is becoming crazy because people are seeing repetitive events – 2008, 2013, 2018 DeMon, 2020 and now 2022. That is creating a flight to safety and that is a big factor where higher yields people are moving to safety.
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The third point is that I think we cannot classify all startups. I am now talking about private capital because that is what I understand, not public. In private capital, are we defining startups as one animal?There are great startups, some very sincere but not as capable startups and then there are some people in a moral hazard regime who are starting companies raising funds with the sheer idea of wanting to create valuation.
People referred to them as fake startups, I refer to them as a moral hazard of both the VCs involved as well as the startups. In my mind, if we take the old fashioned way, I noticed Vinit Sambre talking about how he invests in today’s world. Basically the idea is you go back to fundamentals, find the great startups which are on the right side of the normal distribution and focus on that sub-selection of the 7,000-8,000 companies which are getting funding and we will be in a better position.
Remember Amazon made its first profit even if it is one cent a share in seven years from starting. So, clearly, if you are making good businesses, profits are inevitable. We should distance ourselves from the trifecta of these three elements that we are seeing which is creating a flight to safety; identify the fundamentally great companies like the ones we are fortunate to have had and privileged to have in our portfolio in fund number three and we should then make logical decisions with the Vinit Sambre, Warren Buffett kind of mindset which looks at fundamentals of each company. Nykaa is a fabulous company; Delhivery is a fantastic company. These are absolutely great companies that I could think of straight away. Freshworks is obviously a fabulous company.
I do not want to comment on companies but these are great companies. So I would say look for the right timing and if we are coming to eight times price sales on a pure tech business, it is really a great time.
After moving from a private to a public market, a lot of promoters have realised that the benchmarking is done differently. In the private market, it is about customer acquisition, relevance and growth. In the public market, it is about cash flow, profitability and path to profitability. Nobody is talking about whether is a great company or the relevance of PolicyBazaar. It is just the fact that how these promoters will have to take a rebirth the minute they go public?
Absolutely agree with you, the transition from private to public is fundamentally a change in what the investors are demanding from you. When you are in private space, you go to a board meeting and hear about what is the customer acquisition plan, how will my valuation curve go up, essentially trading valuation as if it was a security.
When it comes to the public space, mature, large investors come to you and ask for four quarters’ projection, the timing of getting operating cash flow and these companies will start behaving like that. Already, in Zomato’s conference calls, they are talking more and more like a public company.
I want to add one small point on a macro basis which is the world I would like to live in. Today the market capitalisation of private capital markets in India is about Rs 20 trillion. The public markets are somewhere in the region of Rs 180-200 trillion. So privates are becoming about 10% of the public market.
So, instead of thinking in terms of startups, think of it about asset allocation and saying private asset allocation and public asset allocation. We just had had an annual client meeting on Friday and it was full of insurance companies CIOs thinking about private capital as a category rather than startups as a category and thinking about capital allocation in a disciplined way.
There is democratised interest. Everybody in the HNI group and ultra HNI group wants to put a crore or two into privates. So privates is an emerging asset class, it demands attention. Today it is at Rs 15-20 trillion. It will become Rs 30-40-50 trillion, Remember, the entire mutual fund equity industry is only Rs 35 trillion today. So Rs 20 trillion is not a small number.
How do you see the compulsions at play for some of the PE players who want to make an exit? Is that the reason why some of these companies were going public? The entire valuation in the public domain has got everybody thinking what happens to the underlying valuation in the private market?
I think that is why I said acchhe, aur acchhe din bhi aayenge, (good times will come). Fundamentally, they definitely get reset to sanity. There was a whole hedge fund mindset that had come in some select companies, where people were just trading the next valuation round regardless of what the business was doing or rather the business was being made to do. That would increase only the valuation curve rather than build good businesses.
Great founders. however great, will be under huge pressure from all these companies. I used to be a person opposing the idea of differential voting rights but more and more, I am getting convinced that founders should be given super majority rights in all these companies, so that they can be one voice of sanity of what is good for the business and not try to get people into this valuation curve mindsets.
The valuation curve has corrected like everything else which means those great founders will now be raising money at lower rounds. I do worry though because from an anti dilution perspective, sometimes the founders get over punished if there is a down round. So we will have to give it some time when people are comfortable to see at least a sideways round or a slight down round or a convertible structure. But I worry more for the founders than for the VCs.
We are seeing Softbank’s Masa on stage during earnings saying we will invest may be half, if not one-fourth of what we did last year. We have seen what has happened with Tiger Global, Sequoia Capital. India is dealing with all kinds of other issues; there are mark downs, mass layoffs, FOMO is turning into JOMO (Joy of Missing Out). So where do you see better days coming from?
I would, in my mind, separate the hedge funds from the real investors. Tiger, Steadview, Falcon and whoever else are hedge funds and their behaviour is different. Their behaviour is as a side pocket of a very large fund hiring a Bain or a McKinsey to select 10 categories across the world find the best companies and go tell them like Masa did, I am going to give you money Yahoo and if you do not take my money, I am going to give it to Google. So you decide whose money you want. I don’t want to discuss that. It is a very different behaviour from a Sequoia which I think is an outstanding long-term investor as are Lightspeed,
, Matrix – all amazing companies and many outside India also.
.Coming to your second point on Sequoia, what are they dealing with? We have risk managers when we invest in a series A where for example, the founder has great ambition like Adam of Human, one or two are going to get into this mode, especially when the moral hazard is greatly increased with this valuation curve drive right. When I am giving you a $2 billion valuation now, you can expect a $10 billion valuation challenge from me. Effectively everything is 5x. So, the founder gets into more moral hazard and something goes wrong. I do not think we should over sweat all of these things. If you make a list of listed companies and moral hazard, that will run many pages.
Look at the number of SEBI cases pending against promoters. Sequoia is a great company and I think if these things happen, it is an exception rather than the rule, I am not worried about that. I just think good times will come because these great companies will now be available at more moderate assumptions. I don’t want to speak for hedge funds. They are behaving in a manner which is not in line with the way venture capital thinks.
Please read Masa’s story. Masa’s conversations with Yahoo is a great learning for all of us.